Spain (finally) requests assistance for its banks

Inflation in China in May did indeed decline to +3.0% YoY (the lowest in 2 years), below the forecast of +3.2% and April’s +3.4%. Food prices rose by +6.4% in May, down from +7.0% in April and non food prices rose by just +1.4% YoY, well below the +1.8% in April. The producer price index fell by -1.4% in May YoY, faster than the -0.7% decline in April and greater than the -1.0% expected. It was also the 3rd straight decline and the longest stretch of declines since 2009. The data suggests that Chinese manufacturers are experiencing a sharp decline in inflation, probably due to declining demand.

Fixed asset investment in non rural areas, declined marginally to +20.1% on a YTD basis, from +20.2% in April. Industrial production rose marginally, to +9.6% YoY, from +9.3% in April, though below forecasts for a rebound to +9.8% – the 1st time its been below 10% for 2 consecutive months in 3 years. Retail sales rose by +13.8% YoY, down from +14.1% in April.
The IMF reported that China is facing “significant downside risks”.

The data confirms that the economy is contracting far more rapidly than expected – the Chinese authorities will be forced to act with further monetary loosening (interest rate and RRR cuts) and a mini stimulus programme. However, they are concerned that any (major) stimulus programme will increase commodity prices (and therefore inflation), as was the case in 2008/9;

The Spanish Economy Minister (Mr Luis de Guindos) announced today that the government will request financing from the EZ. Mr Guindos added that the loan was “on very favourable conditions, more favourable than in the market”. The debt, he admitted, would count as Spanish public debt, suggesting that the EZ will be lending to Spain’s FROB, rather than to the banks directly. He added that the bank-aid conditions would be limited solely to the banks and that the IMF role would be only on an advisory basis ie no further conditions, other than its current commitments to abide by the terms of the fiscal compact – that’s going to be interesting, as Spain has to meet a target budget deficit of just 5.3% of GDP this year, and 3.0% next, which looks like a real stretch – indeed, a number of people would suggest its impossible. The IMF will not be involved in any lending – they recommended new capital injections of at least E40bn, though added that the weakest banks’ needs “would be larger than this”, once all bad loans were accounted for and the restructuring completed. However, the statement suggests that the EZ will have material oversight over the Spanish banks that will need a bail out.

The announcement by Mr Guindos follows a tele conference between EZ finance ministers. EZ officials state that the E100bn to be mentioned was the “top figure” and that the exact size of the funds necessary could not be established as yet. The funds would come from both the EFSF and the ESM – loans from the EFSF do not have preferred seniority status over all private sector debt, though loans from the ESM do, which could concern the Spanish sovereign debt holders. Spain is awaiting the formal IMF report and, in addition, a report from its 2 other consultants and, in addition, auditors. The EZ is finally getting it – they need to act before the smelly stuff hits the fan and have announced a credible number, though I cant help feeling that, at the end of the day, Spain will require far, far more to recap their insolvent banks. The EZ are also concerned about the outcome of the Greek elections on the 17th June. (Source FT)

This is a positive first step, but there are far more (serious) hurdles to deal with eg EZ wide deposit insurance, EZ banking union, far too small EFSF/ESM (will need more funds from EZ countries, which is unlikely – the other alternative is to grant the ESM a banking licence which, in my humble opinion, is more likely) etc, etc

Finally, will this be it for Spain – unfortunately, I very much doubt it. Spanish banks will require more funding and, most likely, Spain itself;

CITI has abandoned plans to gain permission from the FED to return capital to shareholders, following earlier opposition from the FED – clearly the bank fears being turned down again. It will submit new plans to the FED next January. The move is not going to be popular with shareholders.
Next week (most likely), ratings agencies are certain to reduce the credit ratings of a number of US banks – Morgan Stanley is rumoured to be downgraded by 3 notches, but the bank says it is likely to be (just?) two;

President Obama has called for clear rules to resolve disputes in the South China seas, a statement which provides support to the Philippines. Following a meeting with the Philippine President Aquino, a press release by the two leaders “underscored the importance of the principles of ensuring freedom of navigation, respect for international law, and unimpeded lawful commerce” and that territorial disputes should be solved “in a manner consistent with international law and without coercion or the use of force”. The US has agreed to increase military support to the Philippines. The Philippines, as is the case with other countries in the region, have had problems with China, who, in effect, claim that the whole of the South China seas is their territorial waters;

In about 1 months time, the US Supreme Court is set to opine on Obama’s heath care legislation. There are reports suggesting that the Supreme Court will reject the legislation, either in whole or in part. This issue is important, as rejection of the legislation will reduce corporate costs, which clearly will be bullish;

S&P’s stated that they may downgrade the US by 2014 (whilst reaffirming the negative outlook), citing that the US was not cutting spending by enough. Hmmmm;

Good news that the EZ has acted (sort of) ahead of time in respect of Spain. However, as stated above, a number of problems remain, though I accept that this is an important (temporary) fix. In the short term, the news will provide some relief, though most expected such an announcement this weekend – indeed, Spanish markets closed +1.8% higher on Friday, basically telling you that an announcement was imminent. Should be positive for European financials, though the US news re bank downgrades will need to be watched – downgrades are widely expected though, fortunately.

Markets were expecting bad news from China, which should result in a lesser market impact than would otherwise have been the case.

First round of the French Parliamentary elections tomorrow. Going to be interesting.

The IAEA stated that discussions between itself and Iran had broken down. Correct me if I’m wrong, but did the IAEA not say a few weeks ago that they expected to announce an agreement shortly !!!!, something which took most of us by surprise, to say the least. More uncertainty – just what we don’t need at present. The P5 +1 members are due to meet with Iran again, so I suspect we have a little more time. However, the failure of the IAEA negotiations may well increase the price of oil.

Have a great weekend

Kiron Sarkar

9th June 2012

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